Sharing city sales tax revenues with local school districts: facing financial challenges, three cities in Illinois turned to city officials, who raised the local sales tax rate to generate funds in order to help the local school districts.

Good schools are an important component of a strong community.
Therefore, it is in the best interest of both city government officials
and school district officials for the local school district to perform
well, both financially and academically. But does that mean that a city
should be willing to share its tax revenues if school district officials
request financial assistance from the city government?

When called upon to answer that question, three small to mid-sized
cities in Illinois decided to increase their sales tax rates and share
the revenues with their local school districts. Their experiences
provide useful lessons for other jurisdictions under similar
circumstances.

THE THREE CITIES

The cities of Carbondale, Mt. Vernon, and East Peoria, Illinois,
were among the first in the state to share city sales tax revenue with
one or more local school districts. Carbondale (population 26,000) and
Mt. Vernon (population 16,000) are home-rule cities located in southern
Illinois, and East Peoria (population 23,000) is a non-home-rule city
located in central Illinois.

In Illinois, home-rule cities can raise the local sales tax in
quarter percentage-point increments without obtaining voter approval.
Non-home-rule cities must obtain voter approval to raise the sales tax,
are constrained to a maximum rate of 1 percent, and must use the funds
for public infrastructure or property tax relief. The non-home-rule
sales tax statute did not originally include public schools as public
infrastructure; however, the statute has been revised to include public
schools for at least two communities that requested this change. The
local sales tax is imposed on top of the state sales tax, which is
currently 6.25 percent on most items.

THE REQUEST, AND THE RESPONSE

After two failed voter referendums for the construction of a new
high school, school district officials in Carbondale approached the city
government in the late 1990s requesting financial assistance for the
proposed new facility. After a number of options were explored, the city
proposed the idea of raising its home-rule sales tax to help finance a
new school. At that time, the school district also was eligible for a
construction grant from the state government.

The school district held another voter referendum for the
construction of a new high school, and this time the referendum passed.
Although the city sales tax increase was not mentioned in the
referendum, local officials noted that the city's role was well
publicized prior to the referendum.

In 1999, the City of Carbondale raised its home-rule sales tax rate
by a quarter of a percentage point, to 1 percent, bringing the total
sales tax rate in Carbondale to 7.25 percent. The city agreed to give
the school district $800,000 a year over the 20-year life of the bonds
that were issued to finance the new school facility. This constituted
more than half (57 percent) of the annual debt service on the $16
million bond issue.

About five years later, a similar situation occurred in East Peoria
when officials from several school districts approached city officials
requesting financial assistance. The grade school district wanted help
in financing a new school facility and two other districts wanted
assistance with operational costs. The local high school was faced with
a budget deficit and was trying to avoid cuts in staffing and
extracurricular activities. (1) After considering alternatives, city
officials agreed to increase the non-home-rule sales tax and use the
revenues to assist four local school districts (the fourth district was
added prior to the final agreement).

East Peoria is a non-home-rule community; however, as a result of
special state legislation that was previously passed in relationship to
a tax increment financing (TIF) issue, East Peoria is allowed to raise
its non-home-rule sales tax rate without voter approval. A school
referendum was not necessary since the local elementary school district
put its facility plans on hold when the state failed to appropriate
funds for the state school construction grants program. The city and
school districts held public meetings to discuss the proposal and to
allow input from the public.

The East Peoria school districts initially asked for a sales tax
increase of half a percentage point, but the city officials decided on a
quarter percentage-point increase, which was expected to generate
$800,000 a year. This increase brought the total sales tax rate in East
Peoria to 8 percent, comparable to the rate in neighboring cities. The
increase was imposed for 2.5 years, and the revenue was allocated among
the four local school districts using a formula based on enrollment that
was developed by the school districts.

In the City of Mt. Vernon, officials from the local high school
district asked the city government for assistance to help address the
district's financial problems. The district had been experiencing
an operating deficit in its education fund for several years. To obtain
public input, the city held an advisory referendum on a proposal to
increase the city's home-rule sales tax by a quarter of a
percentage point for a period of two years to assist the school
district. The referendum passed, and the sales tax rate was increased in
July 2003. The city agreed to share the sales tax revenues with the
school district up to a maximum of $450,000 per year and to use the rest
of the tax revenues for city purposes. (See Exhibit 1 for a summary of
the three tax-sharing agreements.)

USE OF FUNDS

In Carbondale, the school district's use of city funds was
restricted to the debt service on the bonds for the new school facility
As of 2007, the quarter percentage-point city sales tax was generating
about $1.1 million, so the extra $300,000 was being used for city
purposes.

In Mt. Vernon, the home-rule sales tax increase generated $1.6
million over the two-year period. The high school district received
$900,000, and the city retained the rest of the revenues. There was no
written plan or intergovernmental agreement regarding how the funds
would be spent, but local officials said the school district used the
money for operational purposes. One official said he did not think many
changes were made during the tax-sharing period to address the financial
problems of the high school district.

In East Peoria, the city initially included a list of provisions
that the school districts would have to accept in order to receive the
sales tax revenues. The city wanted the school district to agree to the
following conditions: conduct a study on the consolidation of two of the
grade school districts; not increase the property tax rate except for
limited purposes; continue to support the city's economic
development efforts, including possible expansion of the enterprise
zone; furnish financial and statistical information to the city;
implement cost containment measures; provide an accounting showing how
the city revenue was used; and work with the city and a Mayor-appointed
committee to address how the financial condition of the school districts
could be improved.

The committee was formed with representatives of the school
district and community, with the superintendents and the city manager
serving ex-officio. This committee recommended consolidating the two
grade school districts, decreasing costs through joint purchases, and
making the sharing of city tax funds contingent on test score
improvements. The school districts objected to the conditions, with at
least one school board member questioning if the city council could
legally control the school district's spending decisions. (2)

In the end, the conditions were not enacted, and the school
districts had significant discretion in how the funds could be used. The
districts used the money for energy efficiency projects, after-school
programs, and counseling. Initially, the high school district used the
money to replace student desks and textbooks, and to make repairs;
however, the focus then shifted to the funding of a team-teaching
approach that included the hiring of classroom aids.

ADDITIONAL REQUESTS

There has been additional interest in using tax-sharing agreements
in the three cities. In Mt. Vernon, the high school district officials
requested additional city assistance to help fund a local match for a
state grant for the construction of a new high school. The city's
share was not to exceed $800,000 per year for up to a maximum of 30
years. The city revenue source was not specifically identified; however,
the two main options discussed were an increase in the sales tax or the
fuel tax.

The city and school district held public meetings to discuss the
proposal, followed by a voter referendum for a new high school facility
in 2007. The referendum did not address the proposed agreement with the
city; however, local officials noted that the city's role was
widely publicized. The referendum failed. Local officials identified
various factors that may have contributed to the defeat, including
emotional attachments to the old high school facility, uncertainty
regarding where the city funds would come from, questions regarding the
appropriateness of using city funds, and dissatisfaction among some
residents that there was not a separate referendum on the city's
role in the financing.

The City of East Peoria also received a request from the local
elementary school district and the high school district to extend the
tax-sharing agreement to generate funds for constructing school
facilities. After a series of meetings and presentations, the city
decided to extend the city sales tax increase and use the revenues to
pay debt service on bonds issued by the two school districts for
facility additions and improvements. As part of the intergovernmental
agreements, the school districts agreed to support an extension and
expansion of TIF districts upon request by the city. The high school
district also agreed to allow the city to use the high school
district's stadium when it would not impose a conflict with events
sponsored by the school district.

Downstate, Southern Illinois University Carbondale (SIUC), a
university with enrollment of approximately 22,000, was undertaking fund
raising for a project that would include replacing a sports stadium and
reconstructing a basketball arena. The mayor of Carbondale proposed the
idea of raising the city sales tax to provide financial assistance for
this project. Although some city officials questioned whether the city
should assist a state institution when the city had its own needs, in
2007 the city council voted 4 to 3 in favor of raising the city sales
tax by half a percentage point and using half of the increase for city
projects, and committing the other half to the debt service for the
university initiative. The city has pledged $1 million per year to SIUC
over a 20-year period.

LESSONS LEARNED

When approached for help, a city may be able to offer financially
challenged school districts some type of assistance in the short-run, or
help with the financing of a particular project, such as the
construction of a new school facility. This is especially true when the
city has access to a revenue source such as the local sales tax that is
not directly accessible to school districts. If the public believes that
the school district has legitimate needs, then raising the sales tax
rate to support those needs can be more politically feasible than having
the school district raise the property tax. The sales tax is less
visible, is not paid in a lump sum, and part of the burden typically is
borne by nonresidents. In one of the jurisdictions discussed in this
article, the local paper estimated that about 70 percent of the sales
tax is paid by nonresidents?

If a city is considering raising the sales tax rate to help the
school district, it is important to check what is legally allowed within
a particular state. States vary in terms of whether this type of
agreement is allowed, the types of provisions that are allowed, how the
funds can be used, and the procedures required to approve a tax-sharing
agreement.

It is also a good idea for city officials to address how the school
district will use the funds. One local official noted that sharing city
revenues for a new school facility appears to be a win-win situation,
but that using city funds to address the financial operating problems of
a school district should be avoided. In the latter scenario, he noted,
the school district might not make many changes during the period in
which city funds are received, in essence putting off the changes that
will ultimately be needed to balance the budget. This is not always the
case, however; in the case of the East Peoria high school district, the
superintendent noted that the district made changes to its operating
budget during the tax-sharing period, leading to a balanced budget after
the original agreement expired.

City officials should think about how the proposed sharing of tax
revenue would affect the city's ability to finance competing needs.
As illustrated in Mt. Vernon's original agreement with the school
district and the City of Carbondale's agreement with the
university, one option is to increase the local sales tax rate and
designate one portion of the increase for financing the city's
needs and the other portion for school needs.

The city and the school district need to educate the public and
determine whether the public supports the use of the sales tax to help
the school district. Even if a city is not required to obtain voter
approval, it is still prudent to hold public hearings and provide a
means for alternative views to be presented and discussed.

If it does decide to raise the sales tax rate in order to help the
school district, the city will need to prepare a resolution authorizing
the increase. It is also helpful to develop a written intergovernmental
agreement describing the structure and nature of the arrangement. The
participating entities need to address the terms of the agreement (e.g.,
how much the sales tax will increase, how much the school district will
receive, the length of the agreement). They may also want to address
other issues such as how funds can be used, what type of reporting or
approval process will be used, and what happens if sales tax revenues
are less than what was anticipated. East Peoria, for example, included a
provision stating that the city's sharing of tax revenue would be
decreased if projections indicated that actual sales tax revenues would
be less than the amounts the city received in either 2003 or 2004.

After the agreement is implemented, it is useful for the parties
involved to assess what went well and what could be improved. This
information will be important if a similar situation arises in the
future or if other jurisdictions request advice or information on sales
tax sharing. (Exhibit 2 summarizes the steps in the review and approval
process.)

OTHER COMMUNITIES PURSUE OPTIONS

A law passed by the Illinois Legislature in late 2007 gave voters
in Illinois counties the authority to establish a local option sales tax
for school facility purposes (e.g., construction, rehabilitation,
financing)? With voter approval, a county school facility sales tax can
be imposed in quarter percentage-point increments up to a maximum of 1
percent. The sales tax proposal can be placed on the ballot through a
resolution by the county board or a resolution by school district boards
that constitute at least 51 percent of the student enrollment within the
county. The funds are distributed among the county's school
districts on the basis of student enrollment within the county As of
early 2008, the voters in one county had approved an increase, and other
school boards were discussing this option. (5)

Exhibit 2: City Review
and Approval Process
Receive Request
from School District
Consider Request
* Legal Issues
* Plans for Use of Funds
* Competing Needs
Educate the Public
and Get Feedback
* Public Hearings
* Voter Referendum
if Needed
Pass a Resolution
and Development
a Written
Intergovernmental
Agreement
Implement Agreement
and Conduct
a Post-Agreement
Review

Other municipalities in Illinois also are planning to share city
tax revenues with school districts or are doing so. For example, in
2007, the voters in the non-home-rule Village of Forsyth, Illinois
(estimated population 3,500), approved a referendum to increase the
village sales tax for public infrastructure. (6) The village will
transfer the revenues from a sales tax increase of half a percentage
point to the school district, which will use the funds to pay debt
service on bonds that were issued to finance a new school facility. The
plan is for the school district to repay the village annually over a
specified time period. The village and school district are discussing
joint uses of the new facility In the Chicago metropolitan area, the
Village of Lincolnwood (population 12,400) agreed to share specified
sales tax revenues with the school district in exchange for the
district's support of Village TIF districts and efforts to become a
home-rule community. (7)

CONCLUSION

Is it reasonable to expect a city government to share tax revenues
when a local school district requests financial assistance? One local
official's answer to that question was that it is the
taxpayers' money--let them decide. This would entail educating the
public and then having a voter referendum, or using some other means to
determine if there is sufficient public support. In about a dozen
states, voters have the authority to approve a local option sales tax to
be used for school purposes. (8) As one local official noted, each
community is different. The city and school district need to work
together to discuss options and determine if there is sufficient support
for some type of joint effort.

Notes

(1.) Michael Smothers, "Sharing tax revenue isn't new in
East Peoria--School district may be forced to cut football if request is
denied," Peoria Journal Star, October 22, 2003.

(6.) In the case of Forsyth, the state legislature revised the
definition of public infrastructure to include public schools.

(7.) Village of Lincolnwood, Illinois and Lincolnwood Elementary
School District No. 74, Intergovernmental Agreement, September 9, 1997.

(8.) Gary Kelly, Utilization of a Local Sales Tax to Provide a
Source of Revenue for Three Selected Illinois School Districts, a
dissertation prepared at Southern Illinois University at Carbondale,
December 2006. This dissertation is a good source of additional
information on the initial tax-sharing agreements developed in the three
cities addressed in this article.

BEVERLY BUNCH is an associate professor at the University of
Illinois at Springfield. She conducts research on state and local
government budgeting and financial management and intergovernmental
issues. She previously worked for the State of Texas and the City of San
Antonio.